Should I hold out for the lowest interest rate?
Interest Rate is the top concern of most borrowers in the business world. But, when does it make sense to keep looking for a better rate and when should you be happy with the offer in-hand? We all want good deals and financing is no different. But, we have to recognize that there are multiple parameters to a loan and any of those may hurt our overall goal when we only focus on interest rate.
Loans may include origination fees, prepayment fees, adjustable rates, draw fees, balloon notes, varying terms, extension options and more. So, it is important to pay close attention to every figure. Always calculate the total cost of the loan, especially with longer term loans such as those financing equipment or real estate. And, if there is a prepayment penalty, be sure to consider that cost if you don’t plan to hold the asset for the full term.
The collateral required for a loan can make a big difference too. Some loans with low interest rates require ALL assets as collateral, including accounts receivables, chattel paper, future purchases and sometimes even the owner’s house. A collateral requirement that includes all of these locks out any future financing options because all assets are tied up until you payoff the first loan. Your growth capability becomes limited when there are no options available for financing new inventory, new vehicles, new hires, new locations, etc… If you have plans to grow in the future, the low interest rate may shoot you in the foot!
Even Unsecured Lines of Credit can have fees that increase the overall cost while offering an attractive interest rate. Many lenders providing business lines of credit expect that line to be paid down every few months and fees apply when you don’t reach that threshold. In fact, some have strict requirements that make you jump through hoops in order to pay that principle down, making it difficult to keep the overall cost low.
Finally, the length of time it takes to secure a loan can make a big difference too. If you have a unique opportunity to take advantage of a great deal and need quick financing, the benefit of the purchase usually outweighs the higher rate of a quick loan. In those cases, grab a “decent” loan and keep moving (time really is money). Then, if you want to refinance into something lower later on, that option is usually available, as long as the collateral is good.
While interest rate is certainly important, the lowest rate may not always be the best choice from an overall cost perspective or a flexibility perspective. Make sure you consider all aspects of any loan proposal you are entertaining. Feel free to call me if you have questions